World Shakes Off Nikkei's 7.3% Plunge

Shortly after the Nikkei Stock Average suffered one of its worst single-day declines in decades, a 7.3% drop, Japan's economy minister moved quickly to soothe market fears.

Akira Amari said Japanese stocks in recent months had risen "faster than expected." Weak Chinese manufacturing data in the morning had prompted sellers to "take profits all at the same time," he said.

Markets got a double-dose of bad news, and it sparked a selloff from Tokyo to Berlin to New York. What happens next? Lazard Capital's Art Hogan joins MoneyBeat to discuss the next move in the markets. Photo: Getty Images.

Muted stock declines in Europe and the U.S. show that investors around the globe for now are inclined to agree with Mr. Amari, wagering that Thursday's selloff in Japan is an isolated case of market blues rather than a cause for broader concern.

Many investors continue to argue that global stocks are likely to continue rising, bolstered by improving economic growth, reasonable valuations and hefty support for financial markets from central banks like the Federal Reserve and the Bank of Japan.

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But even some bulls warn that uneven economic data, the sharp rise in U.S. and Japanese stocks and increased interest by short-term investors including hedge funds could pave the way for more-volatile trading.

Japanese stocks are up more than 60% since late November, when Shinzo Abe, now Japan's prime minister, hinted that his administration would sharply increase the money supply in a bid to restart a sputtering economy. The actual bond-buying program didn't start until last month, however, and skeptics stress it is too early to declare victory.

"It's far from certain that these policies are going to work," says Larry Kantor, head of research for Barclays PLC. "It's not like people have seen four quarters of strong growth in the Japanese economy so that they're convinced of the efficacy of these big policy moves."

The pullback in the Nikkei on Thursday started with modest declines that picked up steam after Tokyo's lunch break, with stocks finishing the day at the session low, for the index's biggest one-day retreat in two years. Over the past three decades, declines of such a magnitude have tended to come on days of global weakness—during the international financial crisis in the fall of 2008, for instance. But, on Thursday, no other major markets fell nearly as far as Japan's did.

In the U.S., stocks started the day sharply lower, shaving 127 points off the Dow Jones Industrial Average in the opening minutes of trading, before reversing those losses to push into positive territory by midday. The Dow ended the Thursday session off a modest 12.67 points, or 0.1%.

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Stock tickers in Tokyo on Thursday tell the tale of the market's plunge.
Bloomberg News

In Mr. Kantor's view, the increased role of central banks in driving capital markets means asset-price fluctuations are being driven more by investor speculation over what central bankers will do next, paving the way for erratic moves. "It becomes less about market dynamics and more about central-bank policy and speculation," he said.

Another outsize factor in the recent rally has been the heavy participation of hedge funds and other institutional investors in the U.S. and Europe, who have made betting on the Japanese stock market one of the most popular investments this year.

When these fast-moving hedge funds reverse their bets, however, or see better opportunity elsewhere, the rally could lose an important pillar of support.

Terrence Connelly of Contingent Macro Advisors LLC in Lafayette, Calif., which works with hedge funds, says many of the funds betting on gains in Japanese stocks protected themselves using "trailing stop" orders, which sell stocks at a certain percentage level below the market's current price, in the event of a market pullback. During the Thursday selloff in Japan, many of these orders were triggered, Mr. Connelly says.

Some large funds say they will continue to bet on Japanese stocks but will closely monitor the Japanese bond market. A slow rise in yields could be beneficial to the economy, if it means inflation expectations in the country, but a volatile jolt higher for yields on Japanese government bonds would undermine confidence, the investors said.

Free Fall

In recent decades, the world's major stock indices have all had bad days. See the largest recent single-day plunges in a dozen major indices.

"Abe hasn't done much other than buy a lot of" Japanese government bonds and push the yen lower, says Raj Gupta, who runs Invictus RG Pte. Ltd., a $200 million Singapore-based hedge fund that has been selling its Japanese stock positions over the past few weeks. "None of the structural issues in Japan have been addressed."

Many market watchers continue to see opportunities for future gains on the Nikkei, despite Thursday's pullback.

Michael Kurtz, Hong Kong-based strategist and head of global equity strategy at Nomura, the Japanese investment bank, said the decline appeared to reflect shorter-term tactical moves by traders, rather than a more durable change in thinking among longer-term investors about Japan's prospects. He still sees Japanese stocks as cheap.

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A trader works on the floor of the New York Stock Exchange on Thursday.
Associated Press

While the Fed's latest hints of tapering off its stimulus and the disappointing Chinese manufacturing report may have triggered some investor worries Thursday, Mr. Kurtz said neither "rises to the level of a deep fundamental impairment of Japan's medium-term growth and equity-return prospects."

"In a few weeks' time, we suspect this event will likely be looked back on as having been a helpful buying opportunity," Mr. Kurtz told clients.

Corrections & Amplifications A chart in an earlier version of this article incorrectly showed the opening time of trading. It opened at 9 a.m. and closed at 3 p.m. local time. An earlier version said it opened at 8 a.m. and closed at 2 p.m. A marker on the chart showing when China PMI was released was also incorrectly placed because of this error. Also, the Italian bourse in Milan fell Thursday. An earlier version of this article incorrectly said the bourse was in Rome.

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